Bps speak: the real value in internal management

A 10 per cent increase in internal investment management results in a 4.2 basis points increase in net value added to a pension fund’s bottom line, according to analysis of the CEM Benchmarking database, which has data on more than 380 global pension funds from 1991 to 2007.

In addition a 10 per cent increase in passive management can add 3.2 basis points more in net value added, according to partner at CEM Benchmarking, Mike Heale.

According to analysis of the database, the better performing funds are the large funds because they generally have more internal management, and invest a larger portion in passive management.

“Internal management, on average, has outperformed external management in our database not because of a return outperformance but because of the cost savings,”Â Heale says. “This doesn’t mean it is better to have all your assets managed internally, but at the margin it’s better to have a bit more in internal management.”

According to Heale the assets under management threshold for funds to consider internal management is about $10 billion.

While the CEM investment benchmarking service tracks costs not staff count in particular, Heale says the cost of one additional person and related overheads is a lot cheaper than external management.

“There is pressure from the pension fund side to have sharp pencils regarding costs,” he says.

According to CEM, investment costs have risen across the funds in the past 10 years because external active management has increased, and there have been increased allocations to more expensive asset classes such as private equity and hedge funds.

As an example, in the US external management has increased from 82 to 86 per cent; and external active management, which is a big cost driver, has increased from 60 to 68 per cent, in addition allocations to private equity and hedge funds have gone from 2.6 to 6.3 per cent of assets.

“It has not been productive to seek out value-added active management in a lot of asset classes. Everyone who has invested actively in large cap US equity, for example, has underperformed. The bigger funds have made astute decisions about their core/passive positions.”

The research undertaken by CEM, whose clients include CalPERS, CalSTRS, and Ontario Teachers’ Pension Plan, acts as an input to the asset allocation decision.